Moody's cuts Italy credit rating by three notches (Reuters)

NEW YORK/ROME (Reuters) – Moody's Investors Service cut Italy's bond ratings by three notches on Tuesday, saying it saw a "material increase" in funding risks for euro zone countries with high levels of debt.

Moody's downgraded Italy's ratings to A2 from Aa2, a lower rating than that of Estonia, and kept a negative outlook on the rating, a sign that further downgrades are possible within the next few years.

The move comes after Standard and Poor's cut its rating on Italy to A/A-1 from A+/A-1+ on September 19 and underlines growing investor uncertainty about the euro zone's third largest economy, which is now firmly at the center of the debt crisis.

"The negative outlook reflects ongoing economic and financial risks in Italy and in the euro area," Moody's said in a statement.

"The uncertain market environment and the risk of further deterioration in investor sentiment could constrain the country's access to the public debt markets," it said.

Moody's also said that Italy's rating could "transition to substantially lower rating levels" if there were long-term uncertainty over the availability of external sources of liquidity support.

Italy's mix of chronically low growth, a huge public debt amounting to 120 percent of gross domestic product and a struggling government coalition has caused mounting alarm in financial markets.

The Moody's decision came as little surprise after the agency said on September 17 that it would finish a review for possible downgrade of its rating on Italy within a month.

"It's not that it was unexpected, but it doesn't help the situation at all," said Robbert Van Batenburg, Head of Equity Research, at Louis Capital in New York.

"They have already traded as if there was somewhat of a downgrade in the works, so it will probably force Italian policymakers to embark on more austerity programs. It will put another fiscal straitjacket on them," he said.

Moody's said the likelihood of a default by Italy was "remote," but the overall shift in sentiment on the euro area funding market implied a greater vulnerability to a loss of market access at affordable interest rates.

Italy's borrowing costs have soared over the past three months and have only been kept under control by the European Central Bank's purchase of its government bonds on secondary markets.

An auction of long-term bonds last month saw yields on 10 year BTPs rise to 5.86 percent, their highest level since the introduction of the euro more than a decade ago.

The center-right government of Prime Minister Silvio Berlusconi has been under heavy pressure over its handling of the escalating crisis and recently cut its growth forecasts through 2013.

It is now expecting the economy to expand by just 0.6 percent next year, down from a previous projection of 1.3 percent.

The government last month pushed through a 60 billion euro austerity package -- bringing forward by one year to 2013 a goal to balance its budget -- in return for support for its battered government bonds from the ECB.

(Reporting by Walter Brandimarte and Daniel Bases In New York, Catherine Hornby and James Mackenzie in Rome; Editing by Gary Crosse)

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Moody's cuts Japan rating, blames politics (Reuters)

TOKYO (Reuters) – Moody's Investors Service cut its rating on Japan's government debt by one notch to Aa3 on Wednesday, blaming a build-up of debt since the 2009 global recession and revolving-door political leadership that has hampered effective economic strategies.

Japan is preparing to elect its sixth leader in five years to replace unpopular Prime Minister Naoto Kan, under fire for his handling of the response to a March tsunami and subsequent radiation crisis at a crippled nuclear power plant.

The downgrade, while not out of the blue, served as another reminder of the debt burdens that nearly all of the world's major advanced economies shoulder, even as policymakers struggle to agree on ways to stimulate sub-par growth without massive new spending.

The United States lost its top-tier AAA rating from Standard & Poor's earlier this month, and Moody's warned in June that it may downgrade Italy as Europe's sovereign debt crisis festers.

Moody's new rating on Japan's debt is three notches below coveted AAA status, which Tokyo lost in 1998, but is still classified as high grade. Japan is now the same level as China, which surpassed it last year to become the world's second-largest economy, and one notch below Italy and Spain.

"Over the past five years, frequent changes in (Japan's) administrations have prevented the government from implementing long-term economic and fiscal strategies into effective and durable policies," Moody's said.

Moody's had warned in May that it might downgrade Japan's Aa2 rating due to heightened concerns about faltering growth prospects and a weak policy response to rein in bulging public debt, already twice the size of its $5 trillion economy.

Finance Minister Yoshihiko Noda, a fiscal conservative who has joined the race to succeed Kan, refrained from direct comment on Moody's downgrade. But he said: "Recent JGB auctions have met favorable demand and I don't see any change in market confidence in JGBs."

Analysts said the downgrade was hardly a surprise and the reaction in financial markets was muted.

"I had expected that the rating cut would have taken place after the election for the leadership of the (ruling) Democratic Party of Japan. But looking at the candidates, there seems to be nobody among them who would seriously tackle financial reform, so that's why Moody's went ahead and cut the rating," said Yuuki Sakurai, CEO and president of Fukoku Capital Management Inc.

The risks of an upgrade and a downgrade are equally balanced but it would take a significant development to get the ratings agency to move in either direction, Tom Byrne, Moody's senior vice president and regional credit officer , told reporters.

An earlier agreement to raise taxes to cover welfare costs was a good start at fiscal consolidation, but the best chance for success is a stable government, Byrne added.

Japan's next leader has a mountain of challenges ahead, from battling a soaring yen and forging a post-nuclear crisis energy policy to rebuilding from the tsunami and reining in public debt, while paying for reconstruction and the bulging costs of an aging society.

The March disasters knocked the economy back into recession, and the strength of an expected rebound later this year is being clouded by weak domestic and global demand and recent gains in the yen, which threaten export competitiveness.

The government on Thursday unveiled steps to help firms cope with the yen's recent rise to record highs, including a $100 billion emergency credit facility aimed at making it easier for Japanese companies to buy foreign firms.

It also said it would ask major financial firms to report on dealers' currency positions for the period to the end of September, an apparent attempt to curb speculation.

"We are watching more carefully than before whether there is any speculative activity in the market. We won't exclude any options and will take decisive action when necessary," Noda told a news conference to announce the government measures.

Noda's chances of winning an August 29 ruling party leadership race to pick Kan's successor dimmed this week after former Foreign Minister Seiji Maehara, who says beating deflation should be the top priority, reversed course and decided to run.

TAX HIKES AND TIMING

Most of the seven DPJ candidates eyeing the top job agree Japan must eventually raise its 5 percent sales tax to help fund the ballooning social welfare costs of its fast-aging society.

Only Noda, however, favors raising other taxes soon to fund reconstruction of Japan's tsunami-devastated northeast region, and even he has been toning down that stance lately.

"While most people in the market believe Maehara is very likely to win the election, a swift policy response on debt problems is unlikely to come out soon," said Norihiro Fujito, senior investment strategist at Mitsubishi UFJ Morgan Stanley Securities in Tokyo.

Moody's said Japan needed to achieve 3 percent nominal growth in its gross domestic product to get the deficit under control and that a government plan to double the 5 percent sales tax by mid-decades was not bold enough.

"That's not enough. The government knows that as well," Byrne told Reuters.

The yen barely moved on the downgrade news, trading at around 76.7 to the dollar, while 10-year JGB futures were up 0.08 point at 142.63 at the end of the morning session after initially dipping into negative territory. Japanese stocks fell about 1 percent.

Moody's said the outlook for Japan's credit rating was now stable given the "undiminished home bias of Japanese investors and their preference for government bonds, which allows the government's fiscal deficits to be funded at the lowest nominal rates globally".

Byrne told Reuters that as a rule, the rating was not expected to change for 12 to 18 months.

The downgrade brings Moody's rating for Japan into line with rival agency Standard & Poor's, which cut Japan's rating in January to AA minus, the fourth-highest on its scale.

Moody's downgrade of Japan was its first since 2002, when it reduced the rating to A2, six notches from the top. It had upgraded Japan three times since then, with the last upgrade as recent as May 2009.

Persistent deflation and slow growth has shackled Japan's economy for years, reducing tax revenues available to the government, which has grown to rely on debt issuance to finance a large part of its budget.

(Additional reporting by Wayne Cole in Sydney and Nathan Layne, Chikafumi Hodo and Tetsushi Kajimoto in Tokyo; Writing by Linda Sieg; Editing by Kim Coghill)

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Moody's expects to affirm U.S. rating, negative outlook (Reuters)

NEW YORK (Reuters) – The United States will likely keep its top-notch credit rating from Moody's for now, despite the "limited magnitude" of the deficit reduction plans being discussed in Washington, the ratings agency said on Friday.

But Moody's warned in a report that the confirmation of the Aaa credit will likely come with a negative outlook, meaning there is a risk of a downgrade in the medium term.

That decision will depend on the U.S. economic performance in 2012 and prospects for future deficit-reduction measures, Moody's analyst Steven Hess said.

"If we're convinced that the economy takes off in 2012 and shows very strong growth, that makes the whole process of fiscal consolidation somewhat easier," Hess told Reuters in an interview.

The report from Moody's came four days before the United States says it will run out of cash to pay all of its bills.

In Washington, the House passed a deficit plan that likely will die in the Senate, and President Barack Obama told lawmakers before the vote to stop wasting time and find a way "out of this mess."

Moody's issued the report to clarify its position on the U.S. debt situation, its Chief Risk Officer Richard Cantor said in the same interview.

"Sometimes there is confusion and all the ratings agencies are grouped together," he said.

Standard & Poor's has threatened to cut U.S. ratings in the next few months if the lawmakers fail to come up with a meaningful plan to cut the nation's deficit.

Both agencies seem to agree that deficit-reduction measures of around $4 trillion would be enough for the United States to avoid a rating downgrade.

The difference is that, while S&P has indicated it may downgrade the United States by mid-October if it doesn't see a meaningful deficit-reduction plan in place now, Moody's is willing to give the government more time before making that decision.

PRIORITIZING DEBT PAYMENTS

Moody's expects the government will continue to honor bond payments even if lawmakers fail to raise the debt ceiling before August 2.

"If the debt limit is not raised before August 2, we believe that the Treasury would give priority to debt service payments and could thus postpone a potential debt default for a number of days," Moody's said in its report.

"Revenues would be more than adequate for some period of time to meet those payments, although other outlays would be severely reduced as a result."

The ratings agency warned, however, that a debt default would likely lead to a rating downgrade even if it was "swiftly cured and investors suffered no permanent losses."

Lawmakers in Washington were set to work through the weekend, with a recently-passed plan by Republican House of Representatives Speaker John Boehner expected to die in the Democratic-controlled Senate on Friday night.

Wall Street on Friday ended its worst week in a year, and one equity strategist said the stock market's direction on Monday will rely on the weekend's outcome.

"It exclusively is a function of what does Congress do over the next 48 hours," said Phil Orlando, chief equity market strategist at Federated Investors. "If Speaker Boehner is able to get a deal through over the next two days, we trade higher. If we get nothing constructive and a series of more dueling press conferences we probably open lower."

Moody's noted that the first interest payment of $31 billion on U.S. Treasury debt is not due until August 15.

"This is the first date that a default on bonds could occur," the report said, highlighting that, this year, August is the month when the ratio of interest payments to incoming revenues is the highest.

The agency sees less chance of a default on August 4, when T-bills worth $59 billion mature because it is unlikely that the Treasury would not be able to find buyers to refinance them.

"Should the Treasury be unable to find buyers for an equivalent amount, a default might occur. This scenario seems extremely unlikely, given the role of the T-bill market in both domestic and global financial markets," Moody's said.

(Editing by Carol Bishopric)

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Moody's threatens Spain rating cut (Reuters)

MADRID (Reuters) – Rating agency Moody's put Spain on review for a possible downgrade on Friday, adding to concerns that a Greek rescue package has done little to halt the spread of Europe's debt crisis.

Moody's move to place the Aa2 government bond rating on review cited concerns over growth and said funding costs would continue to be high in the wake of euro zone leaders' bolder moves to curb the Greek crisis last week.

That added to a sense that Spain - and Italy - are still firmly in the firing line, and the euro and Spanish bond prices fell in response.

Particular focus rested on Spain's regional governments, many of whom are struggling with burgeoning debt loads after a decade of reckless spending. Analysts fear control over regions' debt loads is slipping out of the central government's grasp.

Regional authorities will miss their collective budget deficit target by up to 0.75 percent of gross domestic product (GDP), Moody's said, hampering the central government's program of austerity to reduce the overall shortfall.

"Regional governments' finances may prove difficult to control due to structural spending pressures, particularly in the healthcare sector," Moody's said in a release.

International investors are concerned the euro zone's fourth largest economy, hamstrung by anemic growth rates and high unemployment, will fail to put its fiscal house in order and need a Greek-style bailout. Nerves about that have sent bond yields to their highest level in over a decade.

Moody's current rating for Spain is in line with fellow rating agency S&P's AA setting, while Fitch Ratings has the country one notch higher at AA+

PERMANENT BURDEN

The euro fell more than 40 pips against the dollar in response and Spanish bond yields rose. Spain's cost of borrowing over ten years is now 6.11 percent compared to the 7 percent level broadly seen as unsustainable for the euro zone governments at risk in the crisis.

The country's rating remains at a high investment grade, far above those of Greece, Portugal and Ireland.

But while Moody's said any cut for Spain would likely be limited to one notch, it said the Greek package had signaled a clear shift in risk for bondholders across the euro zone.

"The trigger is that the (Greek) deal last week has not really rebuilt confidence across the euro zone so Spain is still on their radar screens with costs rising," said Giada Giani, analyst at U.S. bank Citi.

The Spanish Treasury said the external arguments supporting the ratings review relied excessively on short-term market developments in a letter sent to investors on Friday morning and seen by Reuters.

"Moody's assumes that the current high yields that have been generated by the resolutions around the Greek crisis will become a permanent burden on non-AAA sovereign funding costs," the Treasury said.

Spanish bank shares also fell over 2.4 percent as Moody's placed the debt and deposit ratings of five Spanish banks, including the euro zone's biggest bank Santander, on review for downgrade, in line with the sovereign.

RESCUE FUND CONCERNS

While the Greek rescue package set a precedent for private sector participation in future restructuring in the euro area, Moody's highlighted concerns about when or how the euro zone's rescue fund (EFSF) would be able to engage more strongly in battling the crisis.

"The package has not relieved market concerns over the position of such sovereigns because (i) it sets a precedent for private sector participation in future sovereign debt restructurings in the euro area, and (ii) while an expansion of powers has been proposed for the EFSF, it is not clear when the powers will be implemented," the agency said.

Moody's placed the Aa2 rating of Spain's bank restructuring fund, the FROB, on review for possible downgrade as its debt is underwritten by the sovereign.

The agency also downgraded the ratings of six Spanish regions reflecting the deterioration in their fiscal and debt positions. The regions were Castilla-La Mancha, Murcia, Valencia, Catalonia, Andalusia and Castilla y Leon.

It placed a further seven regional debt ratings under review for downgrade.

The Spanish government has set a deficit target of 1.3 percent of gross domestic product for the 17 regions for this year and next, but some of their new governors say this will be impossible due to previous leaders' fiscal mismanagement.

"That the regions are going to overshoot is clear," said Antonio Garcia Pascual, chief economist for Southern Europe at Barclays Capital in London.

"The question will be whether the central government can create a buffer which is big enough to offset that effect, and that is going to be complicated. In the fourth quarter all the skeletons will start to come out of the closet."

According to a Deutsche Bank study, if all the regions with a deficit above 3 percent in 2010 follow Catalonia's lead in missing the deficit target by a third, it would inflate the overall public deficit by 0.64 percentage points.

The government is aiming for an overall public deficit of 6.0 percent of GDP this year, compared to 9.2 percent of GDP in 2010 -- something that also largely depends on growth.

Data on Friday showed Spain's unemployment inched down to 20.9 percent in the second quarter, remaining by far the highest in the EU.

"There seems to be an indication that there's some stabilization, but the key point is the labor market remains extremely distressed," economist at RBS Silvio Peruzzo said.

(Additional reporting by Paul Day; Writing by Sonya Dowsett; editing by Patrick Graham)

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Moody's warns Greek default almost certain (Reuters)

By Ingrid Melander and George Georgiopoulos Ingrid Melander And George Georgiopoulos – 2?hrs?22?mins?ago

ATHENS (Reuters) – Moody's cut Greece's credit rating further into junk territory on Monday and said it was almost certain to slap a default tag on its debt as a result of a new EU rescue package.

It was the second rating agency to warn of a default after euro zone leaders and banks agreed last week that the private sector would shoulder part of the burden of a rescue deal that offers Greece more cash and easier loan terms to keep it afloat and avoid further contagion.

"The announced EU program along with the Institute of International Finance's statement implies that the probability of a distressed exchange, and hence a default, on Greek government bonds is virtually 100 percent," Moody's said in a statement.

Bank lobby IIF, which led private sector negotiations, aims to attract 90 percent investor participation in the bond exchange plan which comes on top of the EU's new 109 billion euro bailout.

Moody's cut Greece's rating by three notches to Ca, just one notch above default, to reflect the expected loss implied by the proposed debt exchanges.

Greece now has the lowest rating of any country in the world covered by Moody's, which, like Fitch last week, said it would review Greece's rating after the debt swap is completed.

"Once the distressed exchange has been completed, Moody's will reassess Greece's rating to ensure that it reflects the risk associated with the country's new credit profile, including the potential for further debt restructurings," it said.

However, whereas Fitch pledged to quickly give Greece a higher, "low speculative grade" after its bonds had been exchanged, Moody's said it could not forecast when the rating would change or how.

"It all depends how quickly the debt exchange takes place," said Alastair Wilson, Moody's Managing Director for EMEA Credit Policy. "Once we have greater visibility over that, we will reassess the credit profile quite quickly. Whether the rating will change, that's a different question," he told Reuters.

A senior EU official said on Saturday that the aim was to start a voluntary swap of privately-held Greek bonds in late August and conclude it in early September.

Greek bank shares and the broader stock market were unfazed by Moody's action. Analysts said the downgrade and the default warning were priced in and less worrying following assurances provided by the EU deal.

"The EU Council last week effectively secured Greek banks' continued access to ECB liquidity, even in the case that PSI (private sector involvement) triggers a selective default," said Platon Monokroussos, an economist at EFG Eurobank.

The government has repeatedly criticized ratings firms for their downgrades and its spokesman threatened on Monday to end its subscriptions to these agencies as the new rescue package means Greece will not issue new bonds for years.

"All governments pay a subscription to these agencies. We, I think, do not need the reviews anymore. They have no practical value," Elias Mosialos told Radio 9. "Perhaps the finance ministry should end its subscription."

CONTAGION CONTAINED ... FOR NOW

Moody's said it would take into account the possibility of a second default while reassessing Greece's rating.

"Our experience is that relatively small restructurings have often been followed by deeper defaults," Wilson said, adding that he could not say if this would be the case for Greece.

The rescue package for Greece benefits other euro zone countries by containing near-term contagion risks but it was not necessarily positive in the longer run as it set a precedent for private sector involvement in rescue deals, Moody's said.

"The support package sets a precedent for future restructurings should the finances of another euro area sovereign become as problematic as those of Greece. The impact of Thursday's announcement for creditors of Ireland and Portugal is therefore likely to be credit-neutral," it said.

The cost of insuring most peripheral euro zone government debt against default rose on Monday on market doubts that the fresh aid package for Greece agreed last week will protect bigger economies from contagion.

Standard & Poor's and Fitch rate Greece CCC, broadly in line with Moody's rating. S&P has not yet said how the EU summit deal will affect Greece's rating.

(Additional reporting by Cecile Lefort in Sydney; Writing by Ingrid Melander, editing by Mike Peacock)

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Moody's suggests U.S. eliminate debt ceiling (Reuters)

NEW YORK (Reuters) – Ratings agency Moody's on Monday suggested the United States should eliminate its statutory limit on government debt to reduce uncertainty among bond holders.

The United States is one of the few countries where Congress sets a ceiling on government debt, which creates "periodic uncertainty" over the government's ability to meet its obligations, Moody's said in a report.

"We would reduce our assessment of event risk if the government changed its framework for managing government debt to lessen or eliminate that uncertainty," Moody's analyst Steven Hess wrote in the report.

The agency last week warned it would cut the United States' AAA credit rating if the government misses debt payments, increasing pressure on Republicans and the White House to come up with a budget agreement.

Moody's said it had always considered the risk of a U.S. debt default very low because Congress has regularly raised the debt ceiling during many decades, usually without controversy.

However, the current wide divisions between the House of Representatives and the Obama administration over the debt limit creates a high level of uncertainty and causes us to raise our assessment of event risk," Hess said.

Stepping further into the heated political debate about U.S. debt problems, Moody's suggested the government could look at other ways to limit debt.

It cited Chile, widely praised as Latin America's most fiscally-sound country, as an example.

"Elsewhere, the level of deficits is constrained by a 'fiscal rule,' which means the rise in debt is constrained though not technically limited," Moody's said, adding that such rule has been effective in Chile.

It also cited the example of the Maastricht criteria in Europe, which determines that the ratio of government debt to GDP should not exceed 60 percent. It noted, however, that such a rule is often breached by the governments.

In the United States, Moody's said the debt limit had not effectively curbed the rise in government debt because lawmakers regularly raise it and because that limit is not related to the level of expenditures approved by Congress.

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Moody's puts U.S. ratings on review for downgrade (Reuters)

NEW YORK (Reuters) – The United States may lose its top-notch credit rating in the next few weeks if lawmakers fail to increase the country's legal borrowing limit and the government misses debt payments, Moody's Investors Service warned on Wednesday.

Moody's is the first of the big-three credit rating agencies to place the United States' Aaa rating on review for a possible downgrade, meaning the agency is close to cutting the country's rating.

Standard & Poor's placed the U.S. rating on negative outlook on April 18 which meant a downgrade is likely in 12-18 months.

"They are worried they are having these ideological arguments while Rome burns," said Carl Kaufman, portfolio manager at Oster weis Capital Management in San Francisco.

A lower credit rating would cause havoc in financial markets around the world and increase borrowing costs for the U.S. government and businesses, further harming public finances and weighing on the economic recovery.

In a statement, Moody's said it sees a "rising possibility that the statutory debt limit will not be raised on a timely basis, leading to a default on U.S. Treasury debt obligations."

Risks of a default on U.S. Treasuries, traditionally seen as the world's safest investment, have increased since the government reached its legal borrowing limit of $14.294 trillion on May 16.

Congress has refused to raise the statutory borrowing limit until agreement is reached on cutting the fiscal deficit which was $1.29 trillion in the last fiscal year.

The U.S. Treasury Department has said if the debt ceiling is not raised by August 2 it will have to start prioritizing payments.

DEFAULT RISK NO LONGER "DE MINIMIS"

Moody's said the probability there will be a default on interest payments is low, but it is "no longer to be de minimis."

"If the debt limit is raised again and a default avoided, the Aaa rating would likely be confirmed," Moody's said.

"However, the outlook assigned at that time to the government bond rating would very likely be changed to negative at the conclusion of the review unless substantial and credible agreement is achieved on a budget that includes long-term deficit reduction," the firm said.

There is precedent for Moody's decision. In 1996 the firm put some issues of U.S. Treasury debt on watch for a downgrade when the White House and Congress failed to extend the government's debt ceiling.

Moody's decision came after U.S. markets had closed on Wednesday but before Asian markets ramped up their activity. In the 24-hour currency markets the U.S. dollar index, which measures the greenback against a basket of trading partner currencies, had fallen earlier in the session and ended down 1.1 percent, marking the steepest one-day decline since early December.

"In the short-term, the dollar definitely has its problems. This ratings news sent the dollar tumbling. This is really not good," said Brian Dolan, chief strategist at Forex.com of Bedminster, New Jersey.

"Moody's might be doing this based on the politics as much as the threat of default, because the politics have become so problematic.... Between this and (Ben) Bernanke talking about QE3, the dollar could be entering a new downward phase," he said.

The U.S. dollar fell on Wednesday after U.S. Federal Reserve Chairman Ben Bernanke said the central bank could inject more monetary stimulus into the U.S. economy.

The currency fell to a record low against the Swiss franc. The greenback hit a trough of 0.8095 franc, on electronic trading platform EBS.

In after-hours trade, U.S. stock futures dropped 4.8 points to 1307.20 following Moody's decision.

COLLATERAL IMPACT

In addition, the credit ratings for institutions directly linked to the U.S. government were also put on review for a possible downgrade, including Fannie Mae, Freddie Mac, the Federal Home Loan banks and the Federal Farm Credit banks.

The ramifications of a U.S. downgrade could also be felt in places such as Israel and Egypt.

Moody's says the specific bonds issued by these two governments which carry a U.S. government guarantee "were also placed on review for possible downgrade." Israel and Egypt issue bonds without Washington's guarantee, and presumably they would not be subject to the current situation.

The U.S. Congress has routinely raised the nation's debt limit in the past. This time, however, negotiations seem to have stalled over the degree to which the fiscal deficit should be cut by raising taxes or cutting spending.

So far, U.S. Treasury Secretary Timothy Geithner has been able to resort to extraordinary measures to delay a debt default by at least August 2.

Unlike Fitch, which promised to cut the U.S. ratings to "restricted default" after a few missed debt payments, Moody's has said it would downgrade the United States to the "Aa" range, still considered investment grade.

(Reporting by Walter Brandimarte and Daniel Bases; Editing by Leslie Adler and Clive McKeef)

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Moody's cuts Portugal to junk, warns on 2nd bailout (Reuters)

LISBON/NEW YORK (Reuters) – Moody's on Tuesday cut Portugal's credit standing to junk in the first such move by a ratings agency and warned the country may well need a second round of rescue funds before it can return to capital markets.

Moody's Investors Service slashed Portugal's credit rating by four levels, to Ba2, causing the debt-laden Iberian country to follow Greece into junk territory below investment grade. Greece is rated much lower, at Caa1.

Portugal in April became the third euro zone country to request a bailout, after Greece and Ireland.

Moody's cited heightened concerns that Portugal will not be able to fully achieve the deficit reduction and debt stabilization targets set out in its loan agreement with the European Union and International Monetary Fund.

Portugal is receiving funds from a three-year, 78-billion-euro ($112 billion) EU/IMF bailout program and does not need to issue long-term debt in the market until 2013.

But Moody's said there is an increasing probability Portugal will not be able to borrow at sustainable rates in capital markets in the second half of 2013 and for some time thereafter.

There was a "growing risk that Portugal will require a second round of official financing before it can return to the private market, Moody's said, and the increasing possibility that private sector creditor participation will be required as a pre-condition."

It also said Portugal faced formidable challenges in reducing spending, increasing tax compliance, achieving economic growth and supporting the banking system.

Of the three major ratings agencies, Standard & Poor's and Fitch Ratings both have Portugal at BBB-minus, the bottom of the investment grade range.

Portugal's new center-right government said in a statement that Moody's did not take into account strong political backing for austerity after a June 5 election, and an extraordinary tax announced last week.

Unlike the previous minority Socialist government, the new ruling coalition has a comfortable majority in parliament to pass austerity measures and reforms. It did acknowledge, though, that the rating cut "shows the vulnerability of the country's economy amid a debt crisis."

It also reaffirmed commitment to deepening and speeding up austerity measures that the country vowed to implement under its bailout pact, saying a strong macroeconomic adjustment was "the only way to reverse the course and restore confidence."

The country has to slash its budget deficit to 5.9 percent of gross domestic product this year after overshooting its target last year, when the gap was 9.2 percent, and then reduce it to 3 percent by the end of 2013.

Anthony Thomas, Moody's analyst for Portugal, told Reuters "evidence that Portugal is meeting or indeed exceeding its deficit reduction targets" could be a positive that may lead the agency to change its outlook on the country's credit rating to stable from negative.

But he also said the outlook depends a great deal on whether euro zone officials will require private sector participation when extending new financing to the region's troubled countries. Right now, such participation is planned to be only voluntary so as not to cause ratings agencies declaring it a "credit event."

Filipe Garcia, head of Informacao de Mercados Financeiros consultants in Porto, said Moody's move was "a bit extreme" and was likely to exacerbate concerns over Portugal's debt.

"The capacity to return to the markets after a while depends on a more global, structural solution by Europe rather than on what each troubled country does. I think it's too early to think of a second bailout for Portugal right now, not this year at least," he said.

Garcia said the ratings agencies were not taking into account the European Union's political determination to avoid a euro zone member's default, despite the union's strong support for Greece, which is in a far worse shape than Portugal.

"Either they don't believe in the power of the political will by the European Union to avoid default, or they are underestimating this political union," he said.

Robert Tipp, chief investment strategist at Prudential Fixed Income in New Jersey, said the downgrade showed the European debt crisis was unlikely to stop at Greece, which looks set to receive a second bailout.

"Once Greece gets wrapped up, you move on to the next country, and in all likelihood that will be the shape of things to come over the next year or two in the euro zone until the long-term financing trajectory for these countries gets stabilized," he said.

In practical terms, Portugal may have to pay a higher premium to place up to 1 billion euros in 3-month Treasury bills in an auction on Wednesday due to the downgrade.

"It'll probably make the yield a bit worse, but I don't expect anything major, because when you go to the market now you have to have the issue booked in advance," Garcia said. Portugal has opted to stay in the T-bill market after the bailout.

(Additional reporting by Daniel Bases in New York and Sergio Goncalves in Lisbon; Editing by Dan Grebler)

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